Definition: ⁸

Gross Domestic Product or GDP can be defined as the market value of all production for final demand within a given country for a given period. GDP is the most comprehensive of output measures.

Production for final demand means production of goods and services that will not be used for further production in the same country and during the same time period. Thus spending by households for the goods they will use at home is final demand i.e. the goods the household buys will not be used to produce other goods and services. Similarly, investment by business is part of final demand as investment goods are durable and will not be used up within the same time period.

Measuring GDP: ⁸

The Expenditure approach:

Production of final demand, Gross Domestic Product, has four components:

• Consumption Expenditure
• Investment Expenditure
• Government Expenditure
• Net Exports

Consumption Expenditure is the sum of private sector expenditure for goods and services within the households during a period such a year or quarter. The sub categories of Consumption Expenditure are:

1. Services
2. Non-Durable Goods
3. Durable Goods

Investment Expenditure:

Business investment includes all expenditure for goods and services to produce more goods and services in the future. Goods used to produce more goods and services in the future are known as Capital Goods. Within business investment, it is important to distinguish between Increase in Inventories and Fixed Investment. While inventories are stocks of goods kept on a business premises to make easier and convenient transactions, Fixed Investment includes all business capital goods of other kinds. Thus investment has three major components:

1. Business fixed investment
2. Increase in business inventories
3. Residential construction

Government Expenditure:

Government Expenditure includes government purchases of goods and services regardless of whether they are used up during the period or continues in use beyond the period.

Net Exports:

Exports include all expenditure to buy goods produced in the country for final use in other countries.

Since, by definition, Gross Domestic Product for final use and there are just four categories of final use, we can say that GDP is the sum of the four components i.e. sum of Consumption Expenditure, Investment Expenditure, Government Expenditure and Net Exports.

This kind of approach in measuring the Gross Domestic Product is called the "Expenditure approach".
 
 

The income approach:

The "expenditure approach" is not the only approach to the definition and measurement of GDP.

In theory, production and income are the same for two reasons:

1. The real value of money income is what the money can buy and the money can't buy anything that hasn't been produced.
2. The money paid for goods and services becomes income for the people who produced them: wages, interest, rent and profits.

Income Approach – Complications:

Through the income approach, there are a few complications:

1. While Gross Domestic Production is a measure of production within the country income may be earned from factors of production that are used in other countries, such as overseas investments. In other words, income is on a national, not a domestic basis.
2. Not all of Gross Domestic Product is available for consumption or for additions to the country's capital stock. Some of it has to be used to keep up or replace capital equipment used up during the period.
3. Some taxes came out of production before anyone receives income based on the production.
4. Some income is not received in the period in which production takes place. For example, corporations may retain some earnings from their current profits rather than paying them out as dividends in the current year.
5. Some taxes are withheld from income at the time it is paid or spent such as income and excise taxes. In any case, taxes are not part of the income people have available to spend.

Gross National Product:

The first step is to convert Gross Domestic Product (GDP) to Gross National Product.

Net National Product (NNP):

The next step is to allow for the capital and equipment used up during the year. This is done by deducting the value of the equipment used up called "Capital Consumption Allowance (CCA) " from the GNP leaving the Net National Product (NNP) which measures the production available for all uses without reducing the country’s productive capacity.

National Income (NI):

Net National Product is an income measure. However, some taxes are paid before any incomes are paid out. These are Indirect Business Taxes. We remove this indirect business tax from NNP to get National Income.

Wages:

Wages include all wages, salaries and benefits.

Interests:

Include the net interest paid by businesses to individuals.

Corporate Profits:

Includes the net interest paid by businesses to individuals.

Rent:

Includes all income from providing services of houses, land and buildings.

Incomes of Proprietors

For Proprietary businesses, it would be difficult to separate out the components that correspond to wages, rent, interest and profits so proprietor’s incomes are included in National Income as total sum.
 
 

Personal Income (PI):

National Income is a measure of income earned in a given year after indirect business taxes. However not all income earned in a given year is paid in that same year. Thus to get a measure of income paid we adjust NI by adding income received but not earned in the period and subtracting income earned but not paid in the period. This yields personal income.

PI = NI + income currently received but not earned – income currently earned but not received

Disposable Personal Income (DPI):

The last step is to deduct personal taxes such as Income Tax to arrive at the Disposable Personal Income.

Even though Gross Domestic Product is the most common and important measure of national production, references has been made to another concept called the Gross National Product or GNP. GDP and GNP are based on the same ideas and measure closely related things.
 
 

How do the GDP and GNP concepts differ? ⁹

GDP measures production located within the country i.e. GDP covers the goods and services produced by labor and property located in the United States. As long as the labor and property are located in the United States, the suppliers may be either US residents or residents of the rest of the world.

GNP measures production using resources owned by residents of the country i.e. GNP covers the goods and services produced by labor and property supplied by US residents. As long as the labor and property are supplied by US residents the may be located either in the United States or abroad.

GNP can be converted to GDP by subtracting factor receipts from foreigners which represent the goods and services produced abroad using the labor and property supplied by US residents and add factor incomes to foreigners which represent goods and services produced in the United States using the labor and property supplied by foreigners.
 
 

GDP Vs GNP: ⁹

Gross Domestic Product (GDP) is featured as a measure of US production rather than Gross National Product (GNP). This change in emphasis recognizes the GDP is more appropriate for many purposes for which an aggregate measure of Nation’s production is used.

Why feature GDP?

GDP, as defined before, refers to production taking place in the Untied States. It is therefore the appropriate measure for much of the short monitoring and analysis of the US economy. In particular, GDP is consistent with the coverage with indicators such as employment, productivity, industry output and investment in equipment and structures.

In addition the use of facilities comparisons of economic activity in United States with other countries.

GDP is the primary measure of production in the System of National Accounts, the set of international guidelines for economic accounting that the U.S. economic accounts will be moving towards the mid 1990’s and virtually all other countries have already adopted GDP as their primary measure of production.

GNP, however, continues to be a useful concept, as it refers to the income available to US residents as the result of contribution to production, it is related to their contribution to production it is appropriate for analyses related to sources and uses of income.
 
 

Factors generally neglected in GP:

The Genuine Progress Indicator
Redefining Progress proposes a new indicator, one that includes reasonable estimates of costs. Called the Genuine Progress Indicator, or GPI, it includes more than twenty measures of activity ignored in the GDP. In brief, here's a look at those areas and how we might measure them.

Household and volunteer economy
Much of the work in caring for the health and welfare of citizens is done by the family and in the community. GPI assigns a value to household work, at the approximate rate it would cost to hire someone else to do it. The reason why this is important is that despite numerous "labor-saving" appliances and "e-z" housework solutions, the number of hours spent on housework has changed very little over the last 80 years--it's still about 55 hours per week.

Accounting for this activity helps to explain why in a time of increasing hours spent at the office, we seem to have less leisure time than ever before. It is also important to account for the value of volunteer labor, which increasingly shoulders the burden for society's decay.

Crime and safety
The crime cost calculation attempts to assign some value to the intangible medical, opportunity, and psychological costs of crime by treating it as stolen property. From this number is subtracted expenditures on defensive measures such as alarms, security devices, and safe deposit boxes.

The GPI also accounts for the costs of such "defensive expenditures" as auto accident repairs, the costs of water and air purification filters, and so on.

Distribution of income
The growth of real income in the last few decades has not been straight across the board, but very lopsided. During the 1980's, the incomes of the top one percent of households grew by 60 percent, while the income of the bottom 40 percent of households dropped. The GPI adjusts for the disparity by using a "distribution index" which is based on the incomes of the poorest 20 percent of households. When the gap between rich and poor increases, the index brings the overall GPI down, and vice versa.

Resource depletion and degradation of the habitat
The GPI attempts to reverse the perception that extraction of nonrenewable resources such as oil and minerals is an economic gain. For resource depletion, the GPI estimates the replacement cost, or the amount that would have to be invested to find a reasonable substitute.

Likewise, it tries to account for the true costs of air, soil, and water pollution, including losses from fouled recreational areas such as beaches and parks. Loss of farmland is compensated for by calculating the costs of erosion, soil depletion, and urbanization.

Finally, the costs of ozone depletion, loss of forests, radioactive waste management, and so on are factored in.

Loss of leisure
If you work two jobs, as many of us now do, and wonder why you feel like you're just staying even instead of getting ahead, the GPI may have an explanation for that: the loss of leisure time. If we don't have as much of it anymore, we ought to be getting paid for it. The GPI calculates the value of lost leisure time at a going wage rate.

Service costs
When an appliance breaks down, and you have to pay someone to come fix it, is that a gain or a loss? GPI counts it the way it should be counted, using a depreciation rate of 15 percent and an average interest rate of 7.5 percent--a combined 22.5 percent of the costs of durables. By subtracting this out, it avoids the double-counting of "planned obsolescence" and cheap stuff that just isn't made to last. Likewise, the service of roads is included in the calculation. We'll be making progress only when we contribute lasting value.

Adding It All Up
Calculating the GPI and plotting it against the GDP over the last 40 years, Redefining Progress has a different picture of where we really are today: "The GDP would tell us that that life has gotten progressively better since the early 1950s--that young adults today are entering a better economic world than their parents did. GDP per American has more than doubled over that time. The GPI shows a very different picture: an upward curve from the early fifties until about 1970, but a gradual decline of roughly 45 percent since then."

Regardless of the details of cost analysis--and who can argue that assigning values to such intangibles as stress and global warming is a tough task of approximation at best?--the idea of integrating costs into our leading economic measures is key to charting a sustainable course to the future. Redefining Progress is helping to lead the way in this controversial--and vitally important--endeavor